Opinion: Ride the global-reflation trade with BHP

The return of global growth, or the global reflation trade, is one of the under-followed themes in this market, so, if you want to ride it before everyone else, then a great way to do it is with BHP.

By

TomEssaye

St. Jupiter, Fl. (MarketWatch) — One of the best investment themes outperforming the market in 2014 has been to ride what I call the “global reflation trade.” The steady acceleration of economic growth in the U.S., the European Union and now China means we will continue seeing an acceleration in consumption of commodities and raw industrial metals and materials — and that is good news for mega-cap natural-resources firm BHP Billiton.

BHP Billiton
BHP, +0.63%
has been an excellent way to profit from the global-reflation trade, as it has benefitted from global economic growth ramping up in commodity-hungry China, improving fundamentals in the base-metals space, and very strong corporate fundamentals. Though not as sexy as the social-media or tech sectors, the global industrial mining sector, and BHP in particular, are poised to power higher.

Indeed, one of the surprise developments of 2014 has been the return of global economic growth, and specifically, the recent stabilization of growth in China. Just last week, the July “flash” PMIs showed that the major economies of the world (the U.S., EU, Japan and China) all were expanding. The most encouraging numbers were from China, with the Chinese manufacturing-sector PMI surging to a multi-month high at 52.0. The July print showed that manufacturing in China is expanding at its fastest rate in 18 months, and that’s a big tailwind for BHP.

The positive flash readings, along with recent GDP reports and other economic releases, have helped put to rest worries about a potential economic “hard landing” in China, a fear that had been weighing down industrial miners like BHP. Now, however, with the Chinese economy accelerating, and with the Chinese government committed to maintaining “targeted” stimulus packages and infrastructure projects, demand for industrial metals from China is set to rebound — and to benefit investors who own BHP.

In addition to the increased demand for natural resources from the global recovery, we’ve also seen mining companies shutting down unprofitable mines and helping to constrain the supply overhang. Since early 2013, the price of iron ore and other base metals have fallen, with iron-ore prices specifically falling from over $150 per ton to less than $80 per ton, as of this writing.

As is often the case, that price drop has resulted in weak-handed miners shutting down production, and now we’re seeing the supply/demand fundamentals for base metals and iron ore improving. As that the supply/demand situation incrementally improves, that too will benefit BHP.

In addition to the general benefit mining companies get from an increase in metals prices (because the “net asset value” of the company rises), it’s estimated that for every $10 increase in the price of iron ore, BHP should see a 0.7% increase in their annual free-cash-flow growth. That may not seem like a lot, but when you’re dealing with billions of dollars, it adds up to some serious money.

For BHP investors, the increased metrics are especially important, because generally speaking, BHP’s dividend yield, which currently is 3.8%, rises with increases in the free-cash-flow yield. So, simply put, increased free-cash flow should equal an increased divided. Hey, in a world of 0% interest rates, the need for a robust dividend is more important than ever.

Another reason to like and to own BHP has to do with the steps the company is taking to further streamline their operations. The plans include a renewed focus on their Australian iron-ore and base-metals operations, and a divestment of ancillary properties around the globe. This move will trim expenses, and should lead to bigger profits. Also, it’s expected that BHP will announce a three- to five-billion-share buyback when they report earnings results in mid August, a move that will undoubtedly be bullish for BHP shares.

The bottom line here is that we have a mega-cap stock positively positioned to benefit from global growth in a sector that is seeing improving underlying fundamentals. Moreover, the stock pays a handsome yield of 3.8%, and over the past six months, BHP shares have gained nearly 16%. The stock also recently surged to a new 52-week high, making it tempting for any momentum player. To add yet another positive to the BHP story, consider that the stock still trades at a relative value compared to the S&P 500, with BHP trading at 13.2 times this year’s earnings vs. 16 times earnings on the S&P 500.

The return of global growth, or the global reflation trade, as I call it, is one of the under-followed themes in this market, but I don’t think it will be ignored for much longer. So, if you want to ride the global reflation trade before everyone else jumps on it, then a great way to do it is with BHP.

Essaye is from Jupiter, Fla., and he publishes the daily Sevens Report to provide investors with everything they need to know about the markets by 7:00 a.m. in seven minutes or less. (www.sevensreport.com).

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